International Trade, Comparative Advantage, and Protectionism. Trade Surpluses and Deficits. Canada s Major Exports and Imports in 1999 (Table 20.

Transcription

1 International Trade, Comparative Advantage, and Protectionism Chapter 20 Trade Surpluses and Deficits A trade surplus exists when a country exports more than it imports. A trade deficit exists when a country imports more than it exports. 1 2 Canada s Major Exports and Imports in 1999 (Table 20.1) Canada s Balance of Trade, (millions of dollars) Table Corn Laws Theory of Comparative Advantage The tariffs, subsidies, and restrictions enacted by British parliament in the early nineteenth century to discourage imports and encourage exports of grain. Ricardo s theory that specialization and free trade will benefit all trading partners (real wages will rise), even those that may be absolutely less efficient producers

2 Absolute Advantage Comparative Advantage A country has an absolute advantage in the production of a good if it can produce more of the good with a fixed amount of resources than can any other country. (i.e. when the country uses fewer resources to produce a product than the other country) Comparative advantage is the advantage in the production of a product enjoyed by one country over another when that product can be produced at a lower opportunity cost. The opportunity cost of a product is the alternative products that must be sacrificed to facilitate its production. 7 8 Australia and New Zealand: An Example (from Table 20.3) Yield per hectare of wheat and cotton: New Zealand 6 tonnes wheat 2 bales cotton Australia 2 tonnes wheat 6 bales cotton Mutual Absolute Advantage In this example Australia has the absolute advantage in producing cotton and New Zealand the absolute advantage in producing wheat. In cases like this the countries are said to have a mutual absolute advantage Australia and New Zealand: An Example (from Table 20.4) Production Possibilities of Australia and New Zealand Before Trade (Figure 20.1) Total production of wheat and cotton assuming no trade, mutual absolute advantage, and 100 hectares available New Zealand Wheat: 25 hectares x 6 tonnes/hectare = 150 tonnes Cotton: 75 hectares x 2 bales/hectare = 150 bales Australia Wheat: 75 hectares x 2 tonnes/hectare = 150 tonnes Cotton: 25 hectares x 6 tonnes/hectare = 150 tonnes

3 Advantages of Trade and Specialization Production and Consumption of Wheat and Cotton After Specialization (Table 20.5) Both countries are initially restricted to their own PPF which represents all the combinations of goods that can be produced given the countries resources and state of technology. After trade both countries are able to move out beyond their previous resource and productivity constraints Expanded Possibilities After Trade (Figure 20.2) Gains from Trade When One Country Has an Absolute Advantage in Both Goods (Tables 20.6 and 20.7) Yield per Hectare of Wheat and Cotton Total Production of Wheat and Cotton Before Trade (100 hectares) Realizing a Gain From Trade When One Country Has a Double Absolute Advantage (Table 20.8) Comparative Advantage Means Lower Opportunity Cost (Figure 20.3) When countries specialize in producing those goods in which they have a comparative advantage, they maximize their combined output and allocate resources more efficiently

4 Terms of Trade Exchange Rates The terms of trade refers to the ratio at which a country can trade domestic products for imported products. The price of one country s currency in terms of another country s currency. The ratio at which two currencies are traded For any pair of countries, and given domestic prices, there is a range of exchange rates that can lead automatically to both countries realizing the gains from specialization and comparative advantage Trade and Exchange Rates in a Two Country / Two Good World (from Table 20.9) Canadian-Dollar Prices of Lumber and Cloth in Canada and the United States If C$1=US$0.50 (from Table 20.10) Domestic Prices of Lumber and Cloth in Canada and the United States Cloth: US$4/metre Lumber: US$3/metre Lumber: US$4/metre = C$8/metre Cloth: US$3/metre = C$6/metre Since both products are cheaper in Canada, no Canadian will purchase US products but Americans will import both products from Canada Canadian-Dollar Prices of Lumber and Cloth in Canada and the United States If C$1=US$1 (from Table 20.11) Canadian-Dollar Prices of Lumber and Cloth in Canada and the United States If C$1=US$0.80 (from Table 20.12) Lumber: US$4/metre = C$4/metre Cloth: US$3/metre = C$3/metre Lumber: US$4/metre = C$5/metre Cloth: US$3/metre = C$3.75/metre Americans will have no interest in Canadian products but Canadians will convert dollars to purchase (import) both products from the U.S. Americans will have no interest in Canadian products but Canadians will convert dollars to purchase (import) cloth from the U.S

5 Canadian-Dollar Prices of Lumber and Cloth in Canada and the United States If C$1=US$0.75 Trade Flows Determined By Exchange Rates (Table 20.13) Lumber: US$4/metre = C$5.33/metre Cloth: US$3/metre = C$4.00/metre Americans will wish to purchase Canadian lumber and Canadians will convert dollars to purchase (import) cloth from the U.S. If exchange rates end up in the right ranges, the free market will drive each country to shift resources into those sectors in which it has a comparative advantage. Only those products in which a country has a comparative advantage will be competitive on world markets Sources of Comparative Advantage Heckscher-Ohlin Theorem Factor endowments (Heckscher-Ohlin Theorem) The quantity and quality of labour, land and natural resources of a country. Product differentiation The H-O Theorem explains the existence of a country s comparative advantage by its factor endowments: A country has a comparative advantage in the production of a product if that country is relatively well endowed with inputs used intensively in the production of that product Trade Barriers Dumping Protection: The practice of shielding a sector of the economy from foreign competition. Tariffs: A tax on imports. Export Subsidies: Government payments made to domestic firms to encourage exports. Quotas: A limit on the quantity of imports. Dumping is when a firm or an industry sells products on the world market at prices below the cost of production

6 Smoot-Hawley Tariff General Agreement on Tariffs and Trade (GATT) The U.S. tariff law of the 1930 s that set the highest tariffs in US history (60%). It set off an international trade war and caused a decline in trade that is often considered a cause of the worldwide depression of the 1930 s. The GATT is an international agreement signed by the Canada and 22 other countries in 1947 to promote the liberalization of foreign trade World Trade Organization European Union (EU) The body currently responsible for governing world trade. The WTO replaced the General Agreement on Tariffs and Trade (GATT) on January 1, The EU is the European trading bloc composed of Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom. The EU is an example of economic integration which occurs when two or more countries join to form a free trade zone Canada-US Free-Trade Agreement North American Free-Trade Agreement (NAFTA) An agreement which came into effect January 1, 1989, in which Canada and the United States agreed to eliminate all barriers to trade between the two countries over a ten-year period. An agreement, which came into effect on January 1, 1994, signed by Canada, the United States, and Mexico, in which the three countries agreed to establish all of North America as a free trade zone

7 The Gains From Trade (Figure 20.4a) Losses from the Imposition of a Tariff (Figure 20.4b) Foreign producers are able to provide textiles on the world market much cheaper than Canadian producers. Trade lowers the price for Canadian consumers and allocates resources into industries in which Canada has the comparative advantage. A tariff of $1 per metre increases the market price. The government collects the tariff revenue. Loss of efficiency occurs because: Consumers pay a higher price Inefficient producers are drawn into domestic textile production The Case for Protection Review Terms & Concepts Saves jobs Unfair trade practices by other countries Cheap foreign labour Safeguard national security Discourages dependency Safeguard infant industries absolute advantage Canada-US Free Trade Agreement comparative advantage Corn Laws dumping economic integration European Union exchange rate export subsidies factor endowments GATT Heckscher-Ohlin Theorem infant industry NAFTA protection quota Review Terms & Concepts (cont.) Smoot-Hawley tariff tariff terms of trade theory of comparative advantage trade deficit trade surplus World Trade Organization 41 7